Friday, 29 March 2019

On the back of revelations regarding Danske Bank and its
connection to money laundering last year, it was revealed in the news yesterday
that Birgitte Bonnesen, the CEO of Swedbank, had been relieved of her duties
just minutes into the Bank’s AGM in relation to the organisation’s connection
to dirty money. In this post we shall examine these connected cases further and
learn more about the anti-money laundering issues facing banking organisations.

The incredibly reputable Danske Bank, Denmark’s largest
lender, became embroiled in a money laundering scandal last year when it was
revealed they had helped launder
almost €200 billion in Russian and Baltic money since 2007. The case of
Danske Bank revolves around the purchasing of an Estonian Bank that would
become the vessel for money laundering from neighbouring States like Russia and
the Baltic States. The leadership of Danske Bank were not only made aware of
the issues as early as 2010, but actively promoted the increasing of ‘non-resident
business’ i.e. money from non-Estonian Nationals up to a point when, in 2011,
the Estonian Bank generated 11% of Danske’s total profits, despite only
accounting for 0.5% of the bank’s total assets. There were a number of
associated issues, like the bank having nobody
in place as a compliance officer for anti-money laundering (flouting specific
Danish laws in the process) and in 2014 a whistleblower brought to the attention
of the Estonian bank’s leadership the fact that British LLPs (Limited Liability
Partnerships) were being used to funnel money from people closely linked to
Vladimir Putin and the Russian Intelligence Services. In 2015 the Bank closed
its non-resident business in Estonia but they had not gotten away with their
crimes, with Estonian prosecutors arresting 10 people in connection with the
investigation and with Deutsche
Bank’s American subsidiary being dragged into the mire for good measure.

The once reputable Scandinavian sector took a massive hit
over Danske and today Swedbank looks set to add to this degeneration in
standards. The bank was raided this week by Swedish authorities looking for
evidence of fraud and insider trading, whilst the US is
currently probing Swedbank for its role in the Danske Bank scandal. The
rumour is that Swedbank handled more than €135 billion in assets from ‘high
risk clients’ and that the bank’s connection to Danske, and interesting Mossack
Fonseca, is the cause for the probe. The Swedish Prime Minister – Stefan Lofven
– stated that ‘this is absolutely unacceptable’ because scandals such as these ‘destroys
confidence in the financial system which is important for society’. It is
interesting to note that, even in Scandinavia where societal issues are, by and
large, given much more reverence than in Europe and the US, the plague of
transgressive finance has still managed to take a foothold. With Swedbank being
potentially implicated in the Donald Trump affair – there is a suggestion that
the bank handled payments from Ukraine to Trump’s campaign manager Paul
Monafort – it is likely that this is just the start of a very long and very
painful road for the bank, and most likely the Swedish financial system.

In the first of two short posts today, we will look at the
case of the billionaire Sackler Family and their remarkable effect upon
American society. The family, who own Purdue
Pharma amongst a list of other ventures, have this week seen a massive
legal action taken against them by the State of New York who argue that the
company is ‘responsible
for the opioid epidemic’ sweeping through the United States.

The scale of the disaster is tremendous and the opening of
extensive lawsuits will likely see the end of Purdue Pharma and its
competition. However, that is probably wishful thinking. The reality is that
the people behind the company will not suffer or be penalised, the systems they
developed where salespeople were paid
six-figure bonuses for misleading Doctors will not be regulated, and
moreover there is scope for the companies to make even more money. Rather
remarkably, it has been revealed that not only do Purdue have massive stakes in
other more
generalised opioid products, they are now busy
marketing and aggressively pushing the cure
to the social problem they themselves
exacerbated! It is all rather remarkable but not in the least bit
surprising – that big business is encouraged to act in this manner at the cost
of the public is a systemic norm that
has been accepted. One would like to think the New York lawsuit would cause
damage to the operations of the firm and the family, but considering the fact
the cure is raking in billions of
dollars, it is very unlikely.

Thursday, 28 March 2019

In this second post, we will look at the news that Ernst
& Young (E&Y) are facing a massive and highly unusual (for Japan) $9
billion lawsuit for its audit failings that led to investors in Toshiba losing
out significantly. As E&Y have already had issues with Toshiba, it is worth
examining this current instance to see whether this is a continuation of
auditing failings across the globe.

As part of one of Japan’s worst
accounting scandals for some time, E&Y were fined $17.4 million in 2015
for ‘failing to spot irregularities’ in its audit of Toshiba’s accounts. The
firm were banned from taking on new business contracts in the country for 3
months, and at the end of 2015 the firm’s regional Head resigned.
Yet, this week the firm is once again making headlines in Japan for its
performance, or lack thereof. The firm is facing a shareholder lawsuit for $9
billion and is accused of being partly responsible for Toshiba’s failure to ‘disclose
losses at Westinghouse’ during 2012-13. Westinghouse is an American
supplier of nuclear technology, but in 2012-13 was suffering losses that
Toshiba was exposed to on account of its investment in the company. The individual
investors bringing this claim against E&Y argue
that had the losses on Toshiba’s books been made public sooner, then
shareholders would have been more knowledgeable and would have been able to
prevent Westinghouse from purchasing CB&I Stone and Webber in 2015, a move
which compounded the financial distress of the companies involved.

As the case is ongoing it is difficult to suggest what will
eventually happen. The case was originally much smaller and related to a
separate accounting failure in Toshiba, but the investors have decided to add
Westinghouse to the claim. It has been noted that the claim is unusually large
for Japan and, as such, there may be a question to be raised as to whether E&Y
will ultimately be forced to pay such a fee. Perhaps it hinges on the actions
of the auditing firm and its connection to Toshiba; how has the firm performed
since 2015? Have the firm been lenient or softer with their audits to repair
the damage caused by the scandal in 2015? Have the usual conflicts of interest
inherent within the modern auditing business model raised their ugly heads
again? The case will either be struck out or settled privately so we may never
know, but this represents just the latest in a very long line of supposed scandals that continuously revolve
around this industry.

In the first of a series of shorter posts today, we will react
to the news that Goldman Sachs has been handed a financial penalty by the FCA
for misrepresenting a vast number of transactions over the past decade.

The regulator is rightfully cracking down on these breaches
because the data it would obtain from efficient record keeping is used to
identify market abuses and financial crime. Such a widespread and historic
flouting of these regulations fundamentally affects the capability of the
regulator to efficiently monitor the marketplace, which is why the FCA were
clear in their press release that ‘these
were very serious and prolonged failures… accurate and complete transaction
reporting helps underwrite market integrity and supervise firms and markets’.
There is a focus on financial crime across the globe (perhaps in name mostly,
but there is a focus) and this news must be attached to the continuing
developments in Malaysia where Goldman is being sued over its role in the 1MDB
scandal. However, perhaps it is too much of a reach to combine these issues
and suggest that the banks do not take tackling financial crime seriously
enough. Maybe. Yet, one angle that must be rejected is the notion put forward
by Goldman that ‘we
are pleased to have resolved this legacy matter’ – this is not a legacy matter. Furthermore, it would be
preferable to remove this term and concept from the wider conversation because
it is particularly unhelpful. Failings from 2007 to 2017 do not constitute legacy
issues, and the composition of these large organisations and, crucially, their
behaviour, show that very little has changed. The protection afforded by
attempting to designate something as being part of the past ought to be removed
if real and affectual change is to take place in the culture of financial
services across the globe.

Monday, 11 March 2019

In this very short post we will react to the news that broke
today regarding the future of the Financial Reporting Council. We have covered
the FRC on a number of occasions here in Financial
Regulation Matters and the posts have been highly critical of what was a
feeble regulator. We had only looked
previously at the regulator and the fact that it was under review, but
today the final decision was made on the future of the FRC.

Founded in 1990, the Financial Reporting Council was today
confirmed by the Government as being no more. In its official press release,
the Government stated that, after considering the Kingsman Review, the FRC
would be replaced with a new regulator. That regulator will be called the Audit,
Reporting and Governance Authority. The business media are reporting that
the new regulator ‘will
have stronger statutory powers, including the ability to make direct changes to
accounts and powers to require rapid explanations from companies and publish
reports about their conduct in the event of a corporate failure’. Sir John
Kingsman, the author of the report that has underpinned this shakeup of the
regulatory arena, probably set the process in motion when he labelled the
regulator a ‘ramshackle
house’ when the official report was published. In establishing the new
regulator, the Government has been noted as stating that it was ‘strong’
leadership that will ‘change
the culture’ within the accounting sector. However, it is worth noting that
altering the culture in this particular field will be no easy task and, in
truth, it is difficult to see how a different regulator will achieve this. The
first indication of whether there is change on the horizon or whether it is
business as usual will likely be the new regulator’s take on the Big Four’s
claim that they will separate the consultancy arms from the audit arms
themselves – if this is allowed, on the auditor’s terms, then it is business as
usual. Another question is whether the audit industry can indeed undergo any
major change in respect to the tumultuous period awaiting the UK once the country
leaves the European Union – do the Government really have the capital to take
on such a corporate behemoth?

Monday, 4 March 2019

In this post, we will examine the calls made today by a US
Senator in relation to the leading technology companies. We covered the issue of
oligopolies and market dominance in a recent
post, and the issues are the same within the technology sector. However, a
legislative approach that was taken in the 1930s is being cited as a good
approach to take now, which is line with the common mantra in the modern day
where everything was better and more effectual ‘in the past’. In this post we
will take a step back to examine whether that past approach really was
effectual, and discuss whether it really is applicable to the modern marketplace.

The Glass-Steagall Act, otherwise known as the Banking
Act of 1933 (the ‘Glass-Steagall Act’ actually refers to four specific provisions
within the Act), was a piece of legislation enacted in 1933 to combat the size
and development of what is often referred to as ‘universal banking’. The Act
sought to separate commercial and investment banking arms, and thus prevented
the investment banking arms from taking deposits, and the commercial banking
arms from dealing in non-governmental securities (including underwriting such
securities) amongst other aspects. The literature is awash with a number of
reasons for the enactment of the Act, and also differing explanations of the
process of the Act coming to be. The ‘official’ story, for want of a better
term, suggests that on the back of a number of securities-related scandals in
the 1910s and 1920s, there was a political movement to take regulatory and
legislative action within the finance sector. One of the scandals was that of
the so-called ‘Match King’ Ivar Kreuger (analysed in this
brilliant book by Professor Frank Partnoy) which saw the Swedish
businessman develop an array of exotic financial products (many of which went
on to play a major part in the Financial Crisis) that enthralled and eventually
entrapped Wall Street and the public. However, it is widely accepted that it
was National City Bank (the ancestor to today’s Citibank) and its charismatic
leader Charles E. Mitchell that lay at the heart of the reason for the Act’s enactment. Mitchell was quoted in the mid-1920s
as stating that he wanted the bank to sell securities to the public ‘just
as United Cigar Stores sold cigars’. The amount
of securities on offer to the public duly increased, with it being noted
that between 1922 and 1931, securities departments within federally recognised
banks went from 62 to 123, and separate securities affiliates increased from 10
to 114. The effect was an inevitable one, with massive losses incurred by those
who had invested in the securities despite not knowing the true strength of
them – although they were supported and validated by third-parties (a familiar
story). So, in light of this, an investigation was set up and led by Ferdinand
Pecora – what would come to be known as the ‘Pecora Hearings’ – and the
Committee found, after investigation, that a separation of commercial and
investment banking would serve to offer protection to the wider system (amongst
other things). Bankers were blamed for selling ‘unsound
and speculative securities’, commercial banks were accused of converting
bad loans into security issues, and security affiliates conducted pool operations
with the stocks of parent banks; all of this was the evidence needed to push
ahead with the enactment of the legislation.

However, the vast majority of research into this process
since has found that there was no such evidence. Kroszner and Rajan suggest
that, when one considers the delinquency rate from the period, Universal banks
were much stronger as a result of the combination and did
not present an excessive risk. In addition, the quality of the bonds that
the large banks offered defaulted less frequently than purely investment
bank-developed bonds did, according
to Puri. One of the major proponents of this view is George J. Benston, and
more specifically in his 1990 book The
Separation of Commercial and Investment Banking. Benston suggests that
as the data from the time does not point towards a flaw in the Universal
Banking model, ‘financial stability is more likely under universal banking than
specially banking, principally because universal banks are more diversified…’
Benston goes on to make a number of other points regarding the superiority of
universal banking as a model, one being that as long as antitrust laws do their
job there will be no cartelisation as a result of universal banking, although
some of these suggestions are hard to swallow. We will return to that in a
moment, but this concept of cartelisation is important. Benston notes that the
enactment of the Glass-Steagall Act actually precipitated
cartelisation, in that the commercial banks were aided in removing
unprofitable securities arms, and then their competition for customers’
deposits was immediately eliminated by the Act. This is interesting, and is
potentially supported by the fact that after just two years, Senator Glass
recognised that the law ‘was
an overreaction to an extreme situation’. Yet, we must take great care with
this viewpoint. It is offered by those on the economic right, and comes from a
school that was instrumental in deregulating
the sector prior to the Financial Crisis (proponents such as Professor
Charles Calomiris will argue that Universal Banking was not at fault for
the Financial Crisis, with his and many of his supporters arguing that
federally-backed mortgage institutions Fannie Mae and Freddie Mac were actually
at fault).

Another viewpoint into the reasoning behind the
Glass-Steagall Act is in relation to the ‘House of Morgan’. The banking empire
established by the legendary J.P. Morgan forms one half of an epic battle that
saw the US legislative arena caught in the middle. According to Rothbard,
Morgan and the Rockefeller Family, led by John D., would grow within their
respective fields but the families would come to blows as the competition
heated up within the all-important banking sector. Rothbard suggests that the
Rockefellers sought to lobby and secure the loyalty of certain politicians in
order to dismantle the House of Morgan once and for all and, with the Morgan’s
decision to opt for commercial banking rather than its stalwart investment
banking arm, Rothbard suggests that
aim was finally achieved. The entire story, which revolves around the
development of the Federal Reserve and the sheer dominance of the Morgan
empire, is worth studying but it all leads us back to the Glass-Steagall Act.
It is apparent, for whatever reason, that the Act was a coerced movement based
upon political and environment-altering manoeuvrings. If we accept that to be
true, then it calls into question the legislative process of the time and, one
may reasonably argue, the legislative process in general. It also casts a
shadow on the reverence paid to the Act by Cicilline. It will be best left for
another post, but the deregulation of the Act and its provisions in the 1990s
is not so straightforward either (we should not be surprised), so the reality
is that it is extremely dangerous to use something which has not been analysed
properly as the basis for a future legislative or regulatory agenda.

The Glass-Steagall Act did, on the face of it at least,
work. However, there are so many elements to consider a. in its construction
and b. in its effect, that it becomes very difficult to say whether it can be
heralded in the way that Cicilline speaks of the Act. For the technology
industry, and the social importance of its leaders, it is vital that some
control is exerted over their operations. In that sense, Cicilline is
absolutely right. However, the arguable effect of the Glass-Steagall was to
cartelise the banking industry which, if we connect history lineally, is a
direct cause of the concentrated banking arena we witness today in the US (and
this then has a global effect). There needs to be impartial studies undertaken
on the potential effect of separation within the technology industry because
the penalty for not doing so, if we use the banking industry as the example,
would be massive for society. A technology industry that is more cartelised
than it is now is not beneficial for society at all – the legislative body must
take great care in this particular arena, and now is not the time for
romanticising the past.

Contributions are welcome to this blog. If you would like to contribute regarding any area of financial regulation, then please feel free to email me and submit your blog entry. The content should be concerned with financial regulation, and why it matters, but this is broadly defined. The blog is open to all who are professionally concerned with financial regulation, which may range from an Undergraduate Student interested in writing on the subject, to Professors and industry participants.